Capitalogix

November Round Table With John DeTore - Part 2

Peak Capital is running an online roundtable in November with our CIO John DeTore, John Mauldin, and Sam Stovall.  You can check with them to get the full answers from the various panelists, but I wanted to share some of John's answers ahead of time. I previously shared Part 1. This is Part 2 and will finish this piece. 

November 2019 PCM Roundtable 

Peak: Consensus suggests the U.S. economy is slowing and that trend will continue. What might cause an unexpected rise in GDP going into 2020?

John: Well, a cascading set of trade deals would now set us up for that.  It would be politically beneficial for Trump to wrap them up soon.  So that means 1) he will try really hard, and 2) other countries (and his political adversaries) will use that to their advantage. I have no idea who will win that one.  For instance, look for the house to ignore USMCA until the election.

Peak: The Fed takes its cue from the economy, so it is unusual with virtually full employment and strong wage growth they are cutting rates, and everyone expects QE4. Any non-consensus views about the Fed's policy going forward?

John: Well, they are cutting rates not because the economy is weak, but because they figured out that they overdid it in 2018 by raising the rate.  They started out too low, they raised it too much, and are now in the process of fixing it.

Peak: Earnings season started strong with better than expected earnings from banks. Are initial results going to be reflective of the broad market's earnings for the remainder of 2019?

John: Earnings are not going to be a problem for us. 

Last year, earnings benefitted from very substantial corporate tax relief and deregulation.  This will continue for several years, but the benefit is front-loaded, and the tailwind will ease off.

We fall into the trap of looking at year-over-year EPS growth to judge the strength of our public companies.  They are earning good money!  Profits are not being driven down by any undue systematic force.  Even if they don’t grow fast, they are still quite profitable.

Peak: Looking out 12 months, 1 month prior to the 2020 election, do you believe the stock market will be higher, lower, or generally flat from today's level?

John: The market assumes Trump will win and very much will want Trump to win, if only to avoid the painful experiment with the far-left policies of the current Democratic candidates. 

You would think Trump would be unbeatable given the success of the economy and a democratic candidate pool that is oddly positioned to the left of the Democratic party in general. 

But there really is Trump Derangement Syndrome (TDS) in the country today …don’t remember there ever being a President with such venomous detractors since Nixon … right before his resignation.  So, we can’t assume.  And Hillary might get into the race which will cause the market to take off if only for the entertainment value.

The answer to the question is that I am biased to the market being higher.  If it looks like Trump will probably lose the market will have a hard time with this and could be off quite a bit.

Peak: The search for yield has not gotten any easier in 2019. What concerns do you have for pension plans and retirees who require steady income?

John: A lot of concern.  Long-term rates, in fact, act as a negotiation between generations.  Retirees, who need income, lend their life assets to young families, who borrow for home formation.  As discussed earlier, long-term rates are too low.

While “too-low” rates do in general stimulate the economy, lots of awkward or even negative side effects occur:

• Pensions go deeper into unfunded territory because of the assumed discounts on future obligations.
• Low rates mean low mortgage rates. While this is initially good for borrowers, there is an equilibrium that drives up housing prices.  Most of America buys their home with a mortgage and set what they can afford based on what they can borrow.  Low rates push housing prices up.
• While retirees get hurt by low rates, it's unclear if young families will get helped in the long run. They end up with more debt for the payment they can afford.  It can lead to a housing price bubble.
• There are other disruptions of too-low rates like “zombie companies” supported by too-easy credit.

Not to sound all 50’s about it, the solution for income for retirees (that don’t pursue active management) might be to seek out strong US public companies that have significant dividend yields.  The S&P yield is now competitive with bonds.  Remember also that we have gone through a multi-decade process of accepting that stock-buybacks are often preferred by investors to dividend yields.  You don’t just get the dividend payment, you get the buybacks in the form of capital appreciation.

Those who are interested in alpha should find approaches that will work in the new environment.  The three major sources of return available to typical U.S. investors are bond yields, the stock market, and a return from active management.

As yields fall, active management must work less well to keep up.  The bar has been lowered. 

There has been a mass exodus from active management into index funds and ETFs.  So many people I talk to say they don’t want to take the risk of active management.  But a S&P index fund has more risk than most retirees should take with the core of their assets.  Active management in general needs a careful new look by investors.

Peak: Switzerland, Germany and Japan have negative yields going well out on the yield curve. Do you expect negative yields at any point in the U.S.?

John: No … but I didn’t think they would go as low as they have so far either.  

I’ve heard educated arguments that falling yields are a counter-intuitive result of too much government debt.  But this just seems wrong-headed to me.  I brought it up earlier:  the yield of bonds is set by supply and demand.  Supply is certainly up given our deficit spending, but, counter-intuitively, rates are down.   I am left with only one good answer: demand is up more than supply.

My suspicion is that the culprit is the post-2008 waves of regulation with its haircuts to allowed leverage, and complex capital ratios that favor first-world sovereign bonds.  I see no reason why so many would be willing to hold a bond at negative rates unless they really had no legal choice.  The sky is not falling, there are many great places to invest capital for positive rates.

To answer the question, sooner or later we will better understand why negative rates happen.  We should try and fix it. If we don’t, it's probably a matter of time 'til it happens here.

Peak: Correlations between stocks and bonds this year have made maintaining a diversified portfolio relatively easy. Anything on your radar that may make this more difficult in the future?

John: Bonds obviously respond to changes in interest rates.  Stocks, through the P/E ratio, also respond to interest rates in the same way.  Lower rates mean a higher P/E, all things being equal. 

In periods of rapid rate changes or big changes in inflation expectations, the two asset classes will be correlated because they are both responding primarily to rate changes.  Both will have positive returns when rates drop.

Hmm … but right now the market has refused to play this game.  While the yields on bonds are in many cases at ALL TIME LOWS,  the corresponding yields on stocks are near average.  It is as if the stock market is saying: “these really low bond rates are crazy ... this can't last for the next 5-10 years … I’m waiting this out.”  If the market ends its obstinance and plays along, IT WOULD NEED A 50x P/E multiple.  It might even be saying “The stock market is rational, but the bond market is a bubble.”

The stock market is responding to the EPS side of the equation, though.  When EPS come though unexpectedly, the market rises.  When perceived growth increases the market rises (and the bond market falls).

In addition, the market has been really (too) preoccupied with politics and the political divide in the country right now.

This adds up to a low correlation between the stock and bond markets.  It is lower than usual and will eventually go back to normal. 

Catalysts that would cause low correlation to rise: 

1. it will happen naturally if bond yields and P/E ratios normalize,
2. it will also happen if we go into a recession and the stock market re-adopts it “bad news is good news” posture and rises with every rate lowering move by the Fed.

 

Peak: If I gave you a magic wand that allowed you to change just one thing about the financial markets or investing, what would it be?

John: (I genuinely, seriously wish I had invented high-frequency trading back when it was fun and innovative.  I promise I would put my $B’s to good use.)

But seriously, I wish we would pass legislation (tax or regulation) that made it attractive to spinoff companies rather than merge them.  Many evils in our economy stem from too few firms that are too large and influential (drugs, tech, banking).  This is doable and would affect income disparity more than any of the proposals I hear from politicians.  It would add many more senior and middle managers who are talented and can drive innovation better with some independence.

via USFunds

Here Are Some Links For Your Weekly Reading - November 10th, 2019

Here's a quick reminder about Veterans Day.

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• Why Futurists are (Almost) Always Wrong. (ZDNet)
• AI Rising: How Companies, Police and the Public are Already Grappling with Artificial Intelligence. (GeekWire)
• Macallan Bottle Sells for $1.9 Million, Breaks Whisky World Record Again. (Forbes)
• Suzy Batiz's Empire of Odor. (NewYorker)
• The 35 Best CEOs in the World, According to Harvard Business Review. (BusinessInsider)

 

Trading Links:

• Lilium is One Step Closer to Making Its Flying Car a Reality. (FastCompany)
• Gartner: Corporate Blockchain Won't Take off for Another Decade. (News)
• Singapore is the World's Most Competitive Economy. What Can Others Learn? (WEForum)
• The Countries with the Most Millionaires. (Statista)
• The Unicorn Bubble is Bursting. (SeekingAlpha)

 

 

90th Anniversary of Black Thursday

This past Thursday was the 90th anniversary of Black Thursday, a day when sellers on Wall Street panicked and closed approximately 13 million shares on the NYSE ... causing 5 billion in immediate losses and spurring the Great Depression, easily the worst stock market crash in US history. 

 

With 90 years of education, technology and progress under our belts, we can look back at their mistakes assuming that it could never happen again – but could it? 

The years prior to 1929 were filled with post-WW1 optimism and massive speculation. The combined net profits of 536 manufacturing and trading companies in the first six months of 1929 showed an increase of 36.6% over 1928, itself a record half-year. Rural Americans flocked to cities to take part in the excess of the Roaring Twenties. Stock prices were rising and there was massive economic growth. Like many 20 years olds, the '20s was a period where Americans felt invincible, right up until October 24th of 1929. We almost made it out of the decade.  

On the day the 1929 Crash started, 11% of the Dow's value was lost by the opening bell. There was so much trading that the ticker tape reports were backed up. Traders had no idea of the true value of the stocks. Panic.  Suddenly, 5 billion dollars was gone, along with optimism and trust in the system. By Black Tuesday, several stocks sat without buyers and the Dow drops another 12%.  Collective confidence shattered.  Psychological traumas compounded until there was widespread economic PTSD.  Uncertainty spread like wildfire. Owners of businesses were unsure if they could get credit, workers were uncertain of job prospects or whether they'd get paid. As a result, consumption dropped, businesses failed, banks followed, and shortly thereafter, so did the Great Depression. 

From the peak of the Dow (September 3, 1929) to the bottom of the Great Depression (July 8, 1932) the Dow lost 90% of its value. 

 

Human Nature is Human Nature

 

We've since instituted many measures to protect businesses, banks, and consumers, including measures to suspend trading in periods of rapid decline (like the Securities Act of 1933 and the Securities Exchange Act of 1934). As well, we have a better understanding and tracking of economic barometers like car sales, real estate, etc. 

The reality is that in various scales and timeframes human traders undergo the same issues time and time again. It only becomes a talking point when it becomes painful enough. 

It shouldn't take mass unemployment and economic contraction for us to understand the dangers of speculation, the dangers of human fear, greed, and discretion, and the dangers of poor economic theory. 

Human fear and greed will likely play less of a role in markets going forward.  Increasingly more of trading volume is algorithmic.  And increasingly more of the decisions are made with AI using more data and shorter time frames.  As a result, while I expect increased volatility, I also expect increased opportunity.

Keep in mind that there is a difference between guessing and knowing ... and knowing is more profitable.  The corollary is: if you don't know what your edge is ... you don't have one. 

 

 

Here's to a great last few weeks of 2019!

Here Are Some Links For Your Weekly Reading - October 27th, 2019

 

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• Jeff Bezos: This is the 'Smartest Thing We Ever Did' At Amazon. (CNBC)
• The Next Big Thing in AI/ML Is. (DataScienceCentral)
• The Pope's First Wearable is a $110 Rosary that Tracks Your Prayers. (FastCompany)
• Science Says You Only Need to Work out for 13 Minutes to Make a Difference. (Parents)
• The 'Blob': Paris Zoo Unveils Unusual Organism Which Can Heal Itself and Has 720 Sexes. (CNN)

 

Trading Links:

• Salesforce CEO Marc Benioff: Capitalism as We Know It as Dead. (TheVerge)
• Google Claims a Quantum Breakthrough that Could Change Computing. (New York Times)
• Tesla Turns a Profit and Builds a Chinese Factory Very Fast. (Wired)
• There Are Now 11 Blockchain Unicorns in the World, with over $1B Valuation, Including Binance, Ripple, and Coinbase. (TheBlockCrypto)
• SoftBank Says It Has Now Invested $18.5 Billion in WeWork, More Than the GDP' of Bolivia, Which Has 11.5 Million People. (TechCrunch)

Here Are Some Links For Your Weekly Reading - October 20th, 2019

Here are some of the posts that caught my eye recently. Hope you find something interesting.

 

Lighter Links:

• Six Lessons We Can Learn from Geniuses. (BBC)
• Breaking down the 10 Need-to-know Emerging Technologies. (ZDNet)
• Understanding Heart Zone Training: All You Need to Know. (BTW)
• How Spotify's Algorithm Knows Exactly What You Want to Listen To. (OneZero)
• A.I. Musicians are a Growing Trend. What Does that Mean for the Music Industry? (DigitalTrends)

 

Trading Links:

• Jeff Bezos's Master Plan. (The Atlantic)
• "Demystifying Artificial Intelligence (AI) in the Corporation". (Forbes)
• Three Big Things: the Most Important Forces Shaping the World.(CollaborativeFund)
• Goldman Sachs: the Economic Run is Not over and the US 'Is Not Close to Recession'. (CNBC)
• Nobel Laureate Robert Shiller Forewarned Investors about the Dot-com and Housing Bubbles. Now He Tells Us Which Irrational Market Behaviors Have Him Most Worried. (BusinessInsider)

 

Here Are Some Links For Your Weekly Reading - October 13th, 2019

 

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• We May Be Closing in on the Discovery of Alien Life. are We Prepared? (NBCNews)
• An Ant Colony Has Memories Its Individual Members Don't Have. (TheNextWeb)
• Meat is Unhealthy, Meat is Okay: Why Science Keeps Overturning What We Thought We Knew. (Vox)
• Entries in the 2020 Sony World Photography Awards. (The Atlantic)
• Google Has Suspended Its Controversial Field Research' that Allegedly Scanned Homeless People. (TheVerge)

 

Trading Links:

• This Chart Ranks Everyone (Even You) by Their Wealth, and It's a Snapshot of Inequality. (CNBC)
• The Downside to Charles Schwab and TD Ameritrade Eliminating Trading Fees. (MarketWatch)
• Job Losses in 2019 Highest in 4 Years as Manufacturing and Auto Industries Falter . (24/7 Wall St)
• Trump Administration Slaps 25% Tariff on Single Malt Scotch Whisky Imports. (Forbes)
• Former Nasdaq Boss Robert Greifeld Says We'll Remember WeWork as When the 'Unicorn' Bubble Burst. (CNBC)

 

 

Trade Shows & The Evolution Of Trading

I recently participated on several panel discussions about AI and trading. This picture was taken at The Trading Show in New York.

I speak at a number of events every year because I enjoy meeting people pushing the envelope and shaking things up.  It is also a great opportunity to feel the pulse of the industry (by paying attention to the titles of the sessions, the types of sponsors and vendors attracted, and of course, the makeup of the audiences).

Big changes are coming!  Technical innovations and data science insights continue to impress, but the use of alternative data and advanced AI is at a tipping point.  I describe these shifts in the book I’m finishing up, called “Next On Wall Street – Understanding AI’s Inevitable Impact on Trading”.  Let me know if you want to know more about the book.

In the 90s, when I’d go to conferences, I would pay attention to speakers.  Now, when I go to conferences, I'm paying attention to the audience.   The players are changing so fast, the game itself is changing.

 

 

There have been various generations of trading built on different innovations. When computerized data became available, simply understanding how to download and use it generated Alpha. The same could be said for each later evolution: the adoption of complex algorithms, access to massive amounts of clean data, and the adoption of AI strategies.

Each time a new shift happens, traders pivot or fail. The scale of innovation increases, but the pattern remains.

At this most recent conference, I was excited to see people recognizing the pivot toward AI, Big Data and high-speed computing.

Change happens slowly, and then all at once, and we’re getting close to that inflection point.

Onwards!

Here Are Some Links For Your Weekly Reading - September 6th, 2019

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

 

• NASA Chief Scientist Says 'We're Close' to Making Announcements about Life on Mars. (FoxNews)
• Which Drink is Best for Hydration? Hint: It Isn't Water. (CNN)
• Why Does Time Speed up When You Get Older? (Sciencefocus)
• Tinder Wants Users to Find Love in the Apocalypse. (Wired)
• If the Louvre Was on Fire, Should We Rescue the Art First or the People? (3QD)

 

Trading Links:

• Which Billionaire Will Be the World's First Trillionaire?(Entrepreneur)
• The US's Quantum Leap to Dominate AI. (FoxBusiness)
• The Future of Cryptocurrencies. (Worldview)
• 2019 Fourth-Quarter Forecast. (Stratfor)
• What a Trump Impeachment Battle Means for Financial Markets. (NYT)

The Gig Economy: Uber's Woes

I enjoy looking at great disruptive companies and great examples of industries that are primed for disruption.

Think about how many companies have failed due to myopia... Radioshack couldn't understand a future where shopping was done online and Kodak didn't think digital cameras would replace good ol' film. Blockbuster couldn't foresee a future where people would want movies in their mailboxes, because "part of the joy is seeing all your options!" They didn't even make it long enough to see "Netflix and Chill" become a thing. 

The Taxi industry had been ready for disruption way before Uber came along, yet, Uber may have mismanaged their opportunity. Taxis now have a chance to innovate back. 

To run a taxi in New York you need a medallion. There are approximately 13.5 thousand medallions in NYC. In 2013, prices peaked at over 1.3 million dollars for a single medallion. 

The medallion system has been broken for a long time. NYC taxis, in particular, were corrupt and the prices of medallions were artificially inflated by Bloomberg and de Blasio, and built on a debt bubble.

Taxis offered mediocre service, high rates due to artificial caps/greed, and often didn't take credit cards.

They didn't adapt and got disrupted. It's an age-old tale. The same tale as Blockbuster or Kodak; companies thinking linearly in an age of exponential change. 

Taxi agencies had the infrastructure to edge ridesharing out and adopt friendlier policies but were slow to adopt the apps and convenience that modeled ridesharing.

 

via chartr

It's clear that there's an increased demand for rides. Increased demand is likely caused by access in places that didn't previously have enough demand for a full taxi-service. Ridesharing means you can have drivers in small towns, rural areas, etc. Almost all the new demand is being monopolized by ridesharing. 

Should it be, though?

Many would argue Uber's model isn't sustainable; neither are many of these gig-based companies like DoorDash. Uber has a product almost everyone uses, no inventory, very little staff, and despite "winning" the race, it lost $370 million in 2018 and $4.5 billion in 2017.

 

They gained market share by offering lower prices (even at a loss). They also incentivized an army of drivers to join based on flexible hours and side-income.

 

The road to profitability for these companies is uncertain.

 

And the public opinion of Uber is dropping. You have drivers taking out loans to lease cars. You have California making uber classify their workers as employees. You have a review of 14,576 rides showing that these companies take a much larger slice of their drivers' fares than they purport.

 

Uber's low prices got it here, but prices have slowly raised, and AB5 in California has passed, though Uber is claiming exemption - it's likely their prices will jump again if forced to comply.

 

Rideshare companies are trying to convince workers that hour flexibility is worth the non-employee status, but I don't think that has any real basis. Gig workers can't unionize, have little labor protection and don't receive benefits.

 

The industry is in a period of massive disruption - but taxies have a chance to fight back. As the gig economy becomes regulated, the already defined system may regain an edge.

 

In the game of disruption, Uber was shortsighted. In the game of knowing their customers, Taxis were shortsighted.

 

Will taxies see a resurgence as Uber inevitably hikes up rates? Will autonomous fleets put drivers out of business as they will for long-haul freight?

 

Time will tell!

 

Onwards!

Here Are Some Links For Your Weekly Reading - September 15th, 2019

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

 

• New Blood Test Accurately Predicts When People Will Die within 5-10 Years. (BigThink)
• What Brain Supplements Can and Can't Do, According to a Neuroscientist. (FastCompany)
• The No. 1 University in America Now Comes with a Total Sticker Price of Over $293,000. (MarketWatch)
• Tim Cook Used a Specific Communication Strategy in Apple's iPhone Keynote. Here's Why Every Public Speaker Should Too. (Inc)

 

Trading Links:

• Counting on a Black Swan Event? There's an ETF for That. (Bloomberg)
• Jack Ma Ends 20-Year Reign at Alibaba with $41.8 Billion Net Worth. (Fortune)
• China's New Digital Currency Could Encourage Worldwide Use of the Yuan, Says CEO. (CNBC)
• The US Deficit Topped $1 Trillion. the Year's Not Even over Yet. (CNN)
• Trashing Fed 'Boneheads,' Trump Calls for Central Bank to Cut Interest Rates to 'ZERO'. (Politico)